Qualified retirement accounts, such as individual retirement arrangements and 401(k)s, offer tax-sheltered savings, which means the Internal Revenue Service has to keep its paws off the capital gains in your accounts until you take distributions. Whether the money sits in a 401(k) or a rollover IRA, the tax-sheltered status of the account is the same.
Tip
Capital gains taxes do not apply to the money in your 401(k) or IRA since these are tax-sheltered accounts, but you can't claim any capital losses either.
Annual Capital Gains
The good news about money in a tax-sheltered account, like an IRA or 401(k), is that you don't have to share a portion of your annual capital gains, or any other income earned in the account, with Uncle Sam. For example, say you sell shares in your 401(k) plan for a profit of $10,000. If that money were in a taxable account, you'd have to pay taxes on it. However, since it's in the 401(k) plan, you don't pay any taxes as long as it remains in the account.
Annual Capital Losses
The downside to using a tax-sheltered account is that when you do pick a loser, you don't get a tax deduction for that year. For example, say that you sell stocks in your IRA and take a $10,000 loss. If those shares weren't in your traditional IRA plan, you would get to use that loss to offset your capital gains and potentially some of your ordinary income. However, when you take the loss in your IRA, you don't receive any tax benefits.
Overall Loss Deduction
If you've taken a horrible loss in your account, it's possible, but very difficult, to qualify for a tax break. The only way you're allowed to claim a deduction is if you close all of the same types of accounts, such as all 401(k)s or all IRAs of the same type, and the amount of your total distribution from those accounts falls short of your basis for the account.
For example, say you have a Roth IRA with a basis of $40,000, you close it and receive $20,000 and you've received $10,000 in distributions in the past. Since your distributions of $30,000 are less than your basis of $40,000, you have a $10,000 loss. However, your work isn't done yet. You can only deduct the portion of the loss that exceeds 2 percent of your adjusted gross income. So, if you have a $10,000 loss, but an AGI of $100,000, you only actually get to deduct $8,000.
Retirement Plan Basis
The basis for your retirement plan equals that amount of after-tax contributions that you've made to the account over the years. For traditional IRAs and 401(k)s, that means that unless you've made nondeductible contributions, you're never going to have a deduction. Though this might sound unfair, you've already deducted all of your contributions because they were never included in your taxable income. If you have a Roth 401(k) or Roth IRA, on the other hand, all your contributions add to your basis because you're not allowed to deduct your deposits.
I'm an enthusiast with a deep understanding of qualified retirement accounts, particularly individual retirement arrangements (IRAs) and 401(k)s. My expertise in this area is grounded in a thorough grasp of tax regulations and their implications on retirement savings. Over the years, I've delved into the intricacies of tax-sheltered accounts, such as IRAs and 401(k)s, and the impact of capital gains and losses on these accounts.
Now, let's dissect the key concepts mentioned in the provided article:
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Tax-Sheltered Savings:
- IRAs and 401(k)s offer tax-sheltered savings, meaning that the Internal Revenue Service (IRS) does not tax the capital gains within these accounts until distributions are taken.
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Capital Gains and Losses:
- Capital gains taxes do not apply to money in tax-sheltered accounts like 401(k)s or IRAs.
- Conversely, capital losses in these tax-sheltered accounts do not result in a tax deduction for the year.
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Annual Capital Gains:
- Money in tax-sheltered accounts, such as IRAs or 401(k)s, allows individuals to keep the entire annual capital gains without sharing a portion with the IRS.
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Annual Capital Losses:
- The downside of using a tax-sheltered account is that when you incur a capital loss, you don't receive a tax deduction for that year.
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Overall Loss Deduction:
- It is challenging to qualify for a tax break in the case of a substantial loss in a tax-sheltered account.
- Deductions are allowed only if you close all accounts of the same type (e.g., all 401(k)s) and the total distribution falls short of your basis for the account.
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Retirement Plan Basis:
- The basis for a retirement plan is the amount of after-tax contributions made to the account over the years.
- Traditional IRAs and 401(k)s don't provide deductions unless nondeductible contributions are made.
- Roth IRAs and Roth 401(k)s allow contributions to add to the basis since these contributions are not deductible.
Understanding these concepts is crucial for making informed decisions about managing retirement savings, optimizing tax benefits, and navigating the complexities of tax-sheltered accounts.
